Buying a home is one of the most important financial decisions you will make in your life. But it’s also one of the most expensive, and many people are not sure what to do with their home equity. Here are three things you should never do with your home equity.
The alternative ways to get equity out of your home is a broad term that can be applied to many different topics. For this blog, I will cover the three worst ways to use your home equity.
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When the housing market is doing well, one of the many benefits of owning is witnessing an increase in the value of your house. You may enhance your earnings not just by selling your house, but you also have an appreciating asset that you can use to leverage equity as required.
You might accomplish a lot of essential improvements without jeopardizing your long-term financial objectives if you have a strong strategy in place to utilize your home equity properly.
Chainarong Prasertthai/ istockphoto contributed to this image.
What is the definition of home equity?
The difference between the value of your house and the amount you owe on your mortgage is known as home equity. You have negative equity and are underwater on your loan if your mortgage amount is more than the value of your property. You have positive equity if your mortgage amount is less than the value of your house. This equity may be turned into cash.
There are three popular methods to use your home’s equity:
- A home equity loan that is paid off in one single amount. The loan is usually payable in monthly payments over a predetermined period of five to thirty years (similar to your mortgage) and has a fixed interest rate.
- A home equity line of credit (HELOC) is a revolving credit line that functions similarly to a credit card. You only pay interest on what you spend, and your credit line may be used again as long as you have it. HELOCs often have variable interest rates, although fixed-rate HELOCs are available as well.
- A cash-out refinancing is a kind of refinance that enables you to replace your current mortgage with a home loan that is larger than your current debt. You pay the difference in cash between the two loans.
Wichayada Suwanachun/ istockphoto contributed to this image.
The top five methods to get the most of your home’s equity
Once you’ve accessed your home equity, you’re free to do anything you want with the funds. Some methods of leveraging your equity, however, are more responsible than others. Here are a few possibilities.
Tijana Simic/ istockphoto contributed to this image.
1. Improvements to the house
Although using real estate equity to fund your next home improvement project may be a wise decision, not all upgrades provide the return on investment you’re looking for.
According to Remodeling Magazine’s 2020 Cost vs. Value Report, replacing a garage door may provide a nearly 95 percent return on investment. Meanwhile, a typical mid-range bathroom renovation may recover 64 percent of the expenditure, but only around 52 percent of the cost of a master suite expansion.
Of course, whether you want to sell or need to recoup your investment, there are occasions when a home renovation is necessary. If you urgently need a new roof to prevent leaks and other damage to your house, for example, that would be a wise use of home equity, regardless of how it may affect the value of your property.
You may be eligible to deduct mortgage interest paid on a home equity loan, HELOC, or cash-out refi at tax time if you use your equity to pay for home renovations. If you use equity for other purposes, you’ll lose that benefit.
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2. Property investment
You may also use equity to help you get started in real estate investment. Let’s suppose you want to purchase a rental property and need an investment property loan. One of the most important criteria is a minimum down payment of 15% to 20%, depending on your credit score.
For example, to purchase a $200,000 investment property, you’d need a $30,000 to $40,000 down payment, which might come from a home equity loan or HELOC against your primary residence. That property should, in theory, provide enough rental income to cover your mortgage payments (principal, interest, property taxes, and homeowners insurance), as well as upkeep, repairs, and payments on your home equity loan or HELOC.
You may also rinse and repeat the process by leveraging equity in your initial investment property to invest in additional real estate after you’ve built up substantial equity in it.
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3. Increased educational costs
According to Federal Reserve statistics, the national student loan burden is on pace to exceed $1.7 trillion, and college graduates have an average student debt amount of more than $30,000. For nearly anybody, that’s a lot of money, but homeowners with college-aged children may have an advantage: they may use their home equity to help finance higher education costs.
You may be willing to use your home equity to assist your student pay for school or repay their student loan debt if you are a parent. In any case, you may be able to enhance your child’s quality of life by assisting them in achieving educational objectives that will increase their future wages.
nirat/ istockphoto is the source of this image.
4. Health-care costs
If you’re having trouble paying your medical expenses, your potential home equity may be able to help. By using your equity to pay off your medical debt, you may avoid being harassed by debt collectors and try to repair any damage to your credit score.
This is particularly true if you plan to pay medical expenses with high-interest credit card debt. You may be able to get a cheaper interest rate and monthly payment if you use your home equity instead.
Image courtesy of sasirin pamai/istockphoto.
5. Credit card debt consolidation
Using your home equity for debt consolidation may be advantageous depending on how much non-mortgage debt you have.
For example, if you have many thousand dollars in credit card debt, your balance may become too difficult to manage at an average interest rate of 14.58 percent (and as high as 19.29 percent for new card accounts). Meanwhile, the average interest rates for home equity loans and HELOCs are 5.82 percent and 5.61 percent, respectively.
Keep in mind that using equity to leverage debt is only a good idea if you don’t add to your debt once it’s paid off; otherwise, you’ll end up with additional expenses.
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Three of the worst ways to use your home’s equity
Home equity may assist you in achieving your financial objectives, but only if you utilize it properly. Any of the following uses of your equity should be avoided.
Chainarong Prasertthai/ istockphoto contributed to this image.
1. Expenditure on vacations
Exploring Tahiti seems like a fantastic adventure, but you should do it on your own money. Why establish a new monthly payment for years only to fund a week’s worth of expenses? When you use your home equity, keep in mind that your home is being used as collateral, and if you can’t make your payments, you may face foreclosure.
Viktor Gladkov/ istockphoto contributed to this image.
2. Meeting day-to-day costs
If you’re already having trouble paying your monthly expenses, adding additional debt can only make things worse. If you’re experiencing a temporary difficulty and are concerned about falling behind on your mortgage payments, contact your lender to seek a mortgage forbearance or a loan modification.
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3. Investing in assets that depreciate
If you want to purchase a new vehicle or furnishings, think carefully about utilizing your home equity. These things lose value with time, and if you can’t keep up with your home equity loan or HELOC payments, you may lose your house.
This story was syndicated by MediaFeed.org and originally published on LendingTree.com.
Pra-chid / istockphoto contributed to this image.
The home equity loan is a type of loan that uses the value of your home as collateral. This way, you can borrow money from the bank and use it to buy something new. There are three ways to use your home equity for the worst possible reasons.
Frequently Asked Questions
What is the most common use of equity?
Equity is the amount of money that you put into an investment or venture.
How do you pull equity out of your house?
You must first find out the amount of equity you have in your house. This is usually done by asking your real estate agent or using a website like Zillow to figure it out. Once you know how much equity you have, you can then go about selling that equity back to the company that owns the property.
What is the best way to use home equity?
The best way to use home equity is by taking out a mortgage on your house. You can also use it to buy a car, or take a vacation.
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